Medicare Reasonable Costs and "Prudent Buyer"

As the health care system continues to evolve and new methods of reimbursement are developed we want to highlight Medicare “reasonable costs” and the principle of “prudent buyer,” as it can have significant financial implications.

First, there is the definition of “reasonable costs” in section 2102.1 where Medicare recognizes cost can be different from institution to institution, but it also states “except where a particular institution’s costs are found to be substantially out of line with other institutions in the same area which are similar in size, scope of services, utilization and other relevant factors.” This section goes on to say “Implicit in the intention that actual costs be paid to the extent they are reasonable is the expectation that the provider seeks to minimize its costs and that its actual costs do not exceed what a prudent and cost-conscious buyer pays for a given item or service. If costs are determined to exceed the level that such buyers incur, the absence of clear evidence that the higher costs were unavoidable, the excess costs are not reimbursable under the program.”

This referenced “Prudent Buyer” principle is more fully explained in section 2103 and states: “The prudent and cost-conscious buyer not only refuses to pay more than the going price for an item or service, he/she also seeks to economize by minimizing costs.” There is special emphasis where most of the cost is reimbursed by Medicare which could be the case in areas such as Swing Beds and Critical Access Hospitals. It states, “Also, when most of the costs of a service are reimbursed by Medicare examine the costs with particular care.”

Unfortunately, these regulations are usually enforced retroactively and costs may have been paid to the provider which then must be refunded. This usually occurs when the provider’s Medicare Cost Report is under audit or desk review. These scenarios could mean that several years of contractual costs could have been paid and outstanding when the first year is denied by Medicare resulting in several years of refunds to be paid back to Medicare. In some cases, these denied costs could be very large and endanger the financial stability of the entire entity.

As you look at new and different contracts, we urge you to remember these regulations and seek outside counsel when needed. We also recommend any substantial contract be reviewed by an attorney that works regularly with Medicare issues. Our staff is available to help with this review also, but does not replace the need for an attorney’s review.